Smith, Greg dot com

Since we're all going to be talking about tax rates, tax fairness, tax deductions, tax rebates, taxes, taxes, taxes until our head explodes for the next, what? four, eight, hundred years? In this election cycle everyone's arguing over what the "top marginal income tax rate" should be. I figured that since this is Walk Thru History it was time to give a little historical context to US income tax rates...

First of all, let's define our term: the "top marginal rate" refers to the highest possible income tax rate. It's called the "marginal rate" because one only pays the top rate on the marginal dollars that exceed the income brackets the US government sets up. For example, in 2008 a couple filing jointly pays 10% tax on the first $16,000 they earn, they pay 15% on income from $16,000 to $65,000, 25% on income between $65,000 and $131,000 and so on. The 2008 highest marginal rate (after the Bush tax cuts) is 35%, paid on income in excess of $357,000. The following table makes it clear:

Barak Obama says that he will raise the top marginal rate on "the wealthiest 5%" on the population by repealing the Bush tax cuts and raising the top marginal rate to 39%.

Set aside for the moment how slippery his statements have been and how duplicitous his premise is (because many of those 5% are family run businesses, etc.). Let's just ask two questions:
1. How does Obama's proposal measure up to the top marginal rates of previous administrations?
2. Will raising the rate result in collecting more actual revenue for the government?

To answer the first question: the top marginal rate Obama has said he would implement (setting aside the question as to whether that's what he will actually do) is not actually very high compared with where it has been since World War II. The four percent increase from 35% to 39% returns the rate to where it was under Clinton. But consider the following chart. During the Truman, Eisenhower, Kennedy, Johnson, Nixon and Carter presidencies the top marginal rate was between 70-93%! Under Eisenhower it was 91%, meaning that at the top income bracket the Federal Government took 91 cents of every dollar for income tax, and that didn't include other state and federal taxes. Only under Ronald Reagan did rates drop significantly. In fact, Reagan cut the top marginal rate by more than half, from 70% to 28%. Under Clinton that crept back up to 39%. The "radical" Bush tax cuts, which to listen to his critics has caused another Great Depression, only adjusted that top rate back down to 35%, reflected by the little downturn at the end of the chart below.

So, if one were to only consider the top marginal rate, what Obama is proposing is not that big of a deal measured against the history of the tax rate in this country. Of course, the argument can be turned around: if it's not such a big deal to raise it 4% than it wasn't a big deal that Bush cut it 4%, and why not just leave it where it is?

Now let me be clear: I don't think that Obama will stop with this minor fiddling of the top marginal rate. I believe that he will attempt to adjust the entire tax code so that everyone ends up paying more, if not in the income tax rates than in a host of other tax adjustments that could cripple not only families but the businesses that employ them.

But what about the second question: will raising the top marginal rate result in the government receiving more revenue? To answer that question we need only consult Hauser's Law.

Hauser's Law is a theory that states that in the United States, federal tax revenues will always be equal to approximately 19.5% of GDP, regardless of what the top marginal tax rate is. The theory was first suggested in 1993 by Kurt Hauser, a San Francisco investment economist, who wrote at the time, "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP."

You can read an excellent explanation of it here. Here's a quick and simple summary:

Regardless of what the top marginal rate has been in US history since World War II, the federal government has always in the end received about the same percentage of the GDP, or Gross Domestic Product. The GDP is the sum total of all the wealth our economy generates: everything made, bought, sold, etc. It is, if you would, our country's income. And that percentage is always right about 20%.

Historically, empirically, provably whatever percentage the government takes from the income of individual citizens, it always in the end receives only about 20% of the United States' collective income.

Why? Well, when taxes are low the country as a whole becomes more wealthy. When taxes are high it depresses economic activity and the country's income drops. Either way, the government gets about 20% of the pie.

And as every child should be able to tell you (but if they were raised in US public schools there is no guarantee that they actually can tell you) a 20% slice of a REALLY BIG pie is a lot more than a 20% slice of a shrunken pie. This leads us to a counter-intuitive reality which the Left in this country cannot seem to fathom: lower tax rates leads to greater tax revenues.

I have little hope at the moment that the incoming leadership of the United States grasps this truth. Raising the marginal rate by 4% will not make it at high rate by historical standards. It certainly won't approach the 70+% rates of the pre-Reagan era. Yet it will NOT result in more revenue for the government. The likelihood is that the US economy will adjust downward in such a way that the government will get any more pie.

And in the end, don't we all want pie? I know I do. And since the government taking more of my pie means that I'll have less and so will everyone else. Personally, I'd just as soon everyone leaves my pie alone.